`Overvalued' Pound to Fall 20% as Darling Despairs

By Lukanyo Mnyanda and Bo Nielsen

Sept. 8 (Bloomberg) -- Currency traders are starting to take the British government at its word, putting the tumbling pound on course for the worst year since 1992.

The pound is about 20 percent too strong against the dollar, even after falling more than 10 percent this year, according to New York-based International Foreign Exchange Concepts Inc., the world's biggest currency hedge-fund company. Futures traders became more bearish on the U.K. currency than at any time in the past 16 years.

The steepest housing slump in 18 years prompted Chancellor of the Exchequer Alistair Darling to tell Britons they face the biggest slowdown since World War II. The Bank of England kept interest rates unchanged for a fifth month last week to curb inflation that accelerated to 4.4 percent in July, more than twice the central bank's target. During the two previous times the economy cooled since 1997, the pound fell as much as 19 percent, according to data compiled by Bloomberg.

The pound may be ``massively overvalued against the dollar,'' said John Taylor, who oversees $14.6 billion as chief executive officer of FX Concepts in New York. ``They're going to have to go for a cut. I don't know who they think they're kidding by holding out.''

Most Since Soros

The pound's 11 percent slide this year has taken investors and strategists by surprise. The currency ended last week at $1.7661, below the year-end median forecast of $1.85 by 35 firms surveyed by Bloomberg. The last time it fell this much in a year was 16 years ago, when George Soros earned more than $1 billion speculating against the currency and the economy was emerging from its last recession. The pound rose to $1.7830 as of 7:45 a.m. in London today.

In the past two decades, the five major sell-offs in the pound averaged about 22 percent from peak to trough against the dollar, according to Bloomberg calculations. Since reaching a 26-year high of $2.1161 on Nov. 9, the currency depreciated 16.5 percent.

The pound's battering continued last week, after Darling, in an Aug. 30 interview with the Guardian newspaper, said Britain faces ``arguably the worst'' slump in more than 60 years. While Darling said the next day his comments had been misinterpreted, and that he had been referring to the global economy, Hans-Guenter Redeker, the London-based global head of currency strategy at BNP Paribas SA, took him at his word.

``There is no relief out there,'' said Redeker, whose firm was the most accurate forecaster in a 2007 Bloomberg survey. ``A part of the government is giving up hope of this economy doing better in the next couple of years. That tells us a lot.'' The pound will weaken another 2.6 percent by year-end to $1.72, according to BNP Paribas.

Stalling Growth

The U.K.'s longest expansion in more than a century stalled in the second quarter as the economy posted zero growth. House prices fell in August at the fastest annual pace in at least 25 years, HBOS Plc, the nation's biggest mortgage lender, said Sept. 4. The economy will grow 1.4 percent this year and 0.9 percent in 2009, down from 3 percent last year, according to the median of 29 economists' forecasts compiled by Bloomberg.

Until June, the U.K. had clocked up 63 straight quarters of growth as soaring property values fueled consumer spending, propelling former Prime Minister Tony Blair's Labour Party to three election victories. That imploded as credit markets seized up amid the U.S. subprime-mortgage crisis, leading to the first run on a British bank in more than a century when Northern Rock Plc collapsed. Prime Minister Gordon Brown, formerly Chancellor under Blair, nationalized Northern Rock in February.

`Looks Expensive'

``The past weeks and months you have clearly seen the deterioration in growth in the U.K,'' said Andrew Balls, an executive vice president and member of the investment committee of Newport, California-based Pacific Investment Management Co., which oversees almost $830 billion. ``The pound still looks expensive.''

Traders have amassed a net 47,285 futures contracts betting on a pound decline, data from the Commodity Futures Trading Commission in Washington showed on Sept. 5. That's the most since at least 1992 and compares with 1,460 wagers on a stronger pound at the end of July.

The pound has fallen so far so quickly, some technical indicators use to predict changes in direction are signaling a rebound is in the cards.

`Fallen Too Far'

Trading envelopes, which measure how far from the mean a price has strayed, show the pound's decline is more than double the typical changes versus the dollar in the past 20 days. The pound's 14-day relative strength index against the dollar averaged 13 last week, below the level of 30 that signals an imminent gain. The last time the index averaged below 20 was in the week ended March 8, 1985. The pound strengthened 21 percent versus the dollar in the following six weeks.

``For the moment sterling has arguably fallen too far compared to current rate expectation,'' said Michael Metcalfe, the London-based head of macro strategy at State Street Global Markets, which has $14 trillion under custody.

Traders have increased bets the Bank of England will cut interest rates. A Credit Suisse Group index of probability derived from overnight indexed swap rates showed 36 percent odds of a 25 basis-point reduction in the main U.K. lending rate at the Oct. 9 meeting. As recently as July 23, they showed 28 percent odds of an increase. The central bank left its key rate at 5 percent last week.

``Outside of the U.S., the U.K. is where you've seen the most acute impact of the credit crunch on the real economy,'' said Adam Boyton, a senior strategist in New York at Deutsche Bank AG, the biggest currency trader in 2007, according to Euromoney Institutional Investor Plc.

A decline in the U.K. currency to $1.50 by July 2009 is a ``fairly reasonable'' possibility, said Taylor at FX Concepts. Against the euro, the pound may be overvalued by between 5 percent and 10 percent, he said.

To contact the reporters on this story: Lukanyo Mnyanda in London at lmnyanda@bloomberg.net; Bo Nielsen in Copenhagen at bnielsen4@bloomberg.net